Don’t Be Complacent—A Market Correction Is on Its Way

The time to act is close at hand. As long-time readers of my pages are aware, one of my primary concerns about the current economy has been the complacency of investor sentiment. If you look back to any period just prior to a significant market correction, what you will usually find is that investor sentiment had grown almost immune to the possibility of a negative event.

As volatility decreases over time, through a steady climb up for stocks, many investors seem to forget that shocks to the system do occur regularly. This complacent level of investor sentiment lulls people to sleep—until they are awoken by the realization that there are extreme risks present. And that leads to sharp market corrections.

At this point in time—at least from the U.S. perspective—things do appear to be getting better. But there are increasingly worrisome signs that much of the rest of the world is actually moving backwards—toward worsening economic conditions.

The latest news from China shows that the country experienced a much worse-than-expected decrease in exports—3.1% in June year-over-year—one of the worst readings since the depths of the recession in 2009. In addition, imports to China dropped 0.7% year-over-year.

China is in the middle of a significant restructuring program, and they are not keen on pumping additional stimulus into their economy unless they see an emergency scenario.

Their approach is significantly different than what we’ve seen over the past decade, and could lead to lower estimates of gross domestic product (GDP) growth. Of course, that news affects more than just investors in Chinese equities.

The drop in exports signifies that Chinese products are not in high demand, as both the U.S. and the eurozone imported fewer goods from China. However, many U.S.-based corporations are actively involved in trade with China, and so, considering investor sentiment continues to improve, China’s drop in exports points to the fact that much of the world is actually slowing down.

Case in point: Italian government bonds suffered a huge sell-off after a downgrade by credit ratings agency Standard & Poor’s. Again, that should not surprise my readers—I’ve constantly stated that the eurozone remains a mess.

Between China and the eurozone, those two economic regions represent a huge percentage of the global economy. While the U.S. economy has performed extremely well over the past six months in comparison to both of those economic regions, the gains are largely relative.

Still, my worry is that investor sentiment in America is not taking into account the possible shocks we will receive as a result of the slowing global economy. Once investor sentiment begins to shift, this will result in a market correction.

Obviously, no one can accurately predict the exact date of a market correction. But I would tell my readers to be cautious: investor sentiment continues to improve even though the backdrop globally is becoming cloudier.

This blindly optimistic-type scenario often leads to a significant market correction. Once investor sentiment shifts, it could have the same reaction as yelling “Fire!” in a theater—everyone rushes for the exit.